By Steven Turner MD, MBA, Financial Analyst
Recently, a real estate agent compared a Property Assessed Clean Energy (PACE) financing to a traditional construction loan or mortgage and noted that the PACE financing had higher fees and interest rates than that of a customary lender.
This is a common misconception due to the fact that comparing a PACE financing to a common mortgage is akin to comparing apples to oranges.
PACE financing is a special assessment against a property that has had an energy saving upgrade such as new HVAC, windows, roof, lighting, and water treatment with an economic benefit during the financing period equal to or greater than the cost of the project.
It is also commonly used in new construction for costs associated with the aforementioned energy upgrades.
The key word here is assessment. It’s just like a real estate tax. This assessment can be spread out over the useful life of the energy conservation measures such as a new roof, 25-30 years; LED lighting 10-15 years; and HVAC 18-25 years.
There are unique advantages to a PACE financing over traditional construction loans or mortgages.
In a traditional loan, closing costs are due upfront; in PACE, they are amortized in the annual assessments. In traditional construction loans the rate is fixed for the first five years; in PACE, the fixed rate is from to 15-30 years. The length is determined by the state. In Missouri, the maximum term is 20 years. In Nebraska, it depends on the weighted average useful life of the energy conservation measures.
In a traditional loan, the borrower’s credit ratios and balance sheet are affected by the loan balance of a mortgage. In PACE, the property itself is the creditor, and the property owner and personal credit availability are not affected by the PACE financing.
The PACE financing is non-recourse to the property owner or an individual (after completion for ground up development or major redevelopment) in cases of default.
When a property owner defaults on a PACE payment, only the overdue amount, and not the entire balance, is due. Not so with a traditional construction or long-term mortgage: it is due immediately in the case of default.
When a property is sold with traditional financing, the loan is due immediately and needs to be refinanced, often at higher rates.
In PACE financing, the obligation passes through to the subsequent property owner when a property is sold. There are times when the PACE financing is paid off upon sale and it depends upon what makes best economic sense for the new buyer and the seller.
Since PACE assessments typically have a term of 15 to 25 years, and over that period there may be multiple property owners, there is never a need to refinance because the PACE assessment obligations remain attached to the property, unaffected by a change in ownership.
For all these reasons, a PACE financing cannot be compared to a traditional construction or mortgage loan; it’s an entirely different animal.